Fixed Income Markets Then and Now Jason B. Stewart, CIMA Regional Director, Managed Accounts December 4, 2015 Pacific Region Investment Conference
Bond Types and Considerations Municipal Government Corporate Mortgage-Backed Asset-Backed TIPS CDs Credit Ratings Coupon Rates Maturities Duration Yields Call Features Capital Structure
Global Bond Market Today Geopolitical Considerations Accounting Practices Currency Fluctuations Liquidity Quality
Overall Bond Demand Remains Strong
U. S. Bond Market Spectrum
High Yield Bonds Defined All bonds are debt securities issued by organizations to raise capital for various reasons High Yield bonds are issued by companies that do not qualify for investment grade ratings by one or more of the major ratings agencies (Moody s, S&P, and Fitch) These issuers must pay a higher interest rate in order to attract investors to compensate them for the risk associated with investing in organizations of lower credit quality
U. S. High Yield Bond Market Moody's S&P Lower Aaa AAA Aa AA Investment Grade A Baa A BBB Risk/Yield High Yield Ba B BB B Caa CCC C D Higher Highly Leveraged High Risk/Return Troubled Credit Takeover Potential
U. S. High Yield Bond Market Overview Source: J.P. Morgan
Who Issues High Yield Bonds? Fallen Angels formerly investment grade Rising Stars small or newer companies High Debt Companies refinancing debt, takeovers Capital Intensive Companies (cable TV, telecom) Foreign Governments and Corporations Source: SIFMA
The High Yield Bond Market by Sector Energy Exploration & Production gets all the headlines
Who Issues High Yield Bonds? Sprint Corp First Data Corportation Chrysler Group LLC Reynolds Group Tenet Healthcare Softbank Corp Royal Bank of Scotland Dish DBS Corp Rite Aid Corp Hilton Worldwide Caesars Entertainment Wynn Las Vegas MGM Resorts Alcoa Source: ishares HYG Holdings
Investing in High Yield - Benefits A high rate of income due to the higher interest rates of the bonds Low correlation with other parts of the bond market Often perform well in a rising interest rate environment Investment Grade bonds trade on interest rates and rate expectations. HY tends to trade on credit and economic sensitivity. The potential for capital appreciation if the bond is upgraded or if tendered at a premium by the issuer
Correlations in the Bond Market High Yield Correlation to 10-Year -.24 Yield 8.04% Source: JP Morgan Guide to the Markets 9/30/15
Diversification Benefit of Investing in High Yield 25 Year High-Yield/ High Grade Trade-Off Source: J.P. Morgan
Historical Composition by Quality (MV%) Trailing 5 Years 84% BB or B
Avg. Return High Quality vs. Lower Quality Higher Returns with Less Risk 11% 10% BB B 9% 8% CCC 7% 10% 20% 30% (1985-2013) Standard Deviation Source: Bloomberg
Quality Matters Esp. in Energy Exploration & Production
Quality Matters Throughout the Index
Returns and Volatility Vary - CCC
Returns and Volatility Vary BB A Smoother Experience
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Percent High Quality vs. Lower Quality Defaults by Credit Rating BB B CCC 70 60 50 40 30 20 10 0 Source: Moody s
High Yield Now
Conclusion The US High Yield Bond Market Offers: A large opportunity set High current income Low correlation to other bonds Historical performance when interest rates rise Portfolio diversification benefits Attractive total return potential Absolute and risk adjusted (Sharpe Ratio) Compelling returns with manageable risk Credit research, duration management, quality constraints, sector diversification, active management